How to calculate chargeable gains tax on investment bond

carboot_karaoke

Good morning,

I have just found out that what l thought was a savings account l opened as a teenager is actually, or at some point has become an investment bond.
Over the years the value has gone up and down last year, the value only increased by £45 but the total fund is still sufficient to clear our mortgage.
I have been considering making a partial or full surrender to pay off my ever increasing tracker mortgage but wanted to be clear on the tax implications first.

Below is a summary of the account

Account Opened - June 1997
Total Payments in since account opened - £22,495.00
Total Withdrawals since account opened - £2,500
Current cash in value (subject to change) - £35,351.00

The minimum l would like to withdraw is £20,000 to clear my mortgage. But ideally l would like to withdraw the full amount and put the balance into an ISA. An account l can actually understand 

Any advice or simple explanation would be welcomed. 

Linton

There is no simple explanation of investment bond taxation!  

To illustrate the basic principles...

Assume this is a standard onshore investment bond, which it almost certainly is.
Assume you will be withdrawing £20K in the 2023/2024 tax year
Assume that £15000 was contributed in 1997 and £7495 in 2020.
Asdume you withdrew £2500 in 2010


1) Determine amount of withdrawal liable for tax:

There is a tax free allowance of 5% of the contribution per year.  So in the assumed case this allowance is 100% of £15000 + 3/20 X £7495 giving £16124.

So up to £16124 of your total withdrawals will be tax free.  But you have already withdrawn £2500 which would have been tax free at the time because of the 5% rule.  So the unused allowance is £16124-£2500=£13624.

So if you withdraw £20K now you may be charged tax on £20K-£13624=£6376


2) Calculate simple value of tax due

Withdrawals from investment bonds are charged to income tax but it is deemed that the bond has already paid basic rate tax.  So the amount of the withdrawal liable to tax is added to your other taxable income in the tax year and if the total is below the starting point for higher rate tax there is no further tax to be paid on the withdrawal.

So assume your taxable income from employment for the year was £40K.  Including that portion of the withdrawal liable to tax gives you £46376 which is below the start of higher rate tax.  Therefore you will not be taxed on your withdrawal.

However if your taxable income was £50K then your withdrawal would put you into the higher rate band and you would have to pay the higher rate component 20% tax on the excess or more if the withdrawal took you into the even higher bands.

Or you may not because of a further complication known as "top slicing" which can remove the liability to higher rate tax if the withdrawal takes you from basic rate into a higher rate band.  However I wont try to explain this unless you are in that situation.

carboot_karaoke

Linton said:

There is no simple explanation of investment bond taxation!  

To illustrate the basic principles...

Assume this is a standard onshore investment bond, which it almost certainly is.
Assume you will be withdrawing £20K in the 2023/2024 tax year
Assume that £15000 was contributed in 1997 and £7495 in 2020.
Asdume you withdrew £2500 in 2010


1) Determine amount of withdrawal liable for tax:

There is a tax free allowance of 5% of the contribution per year.  So in the assumed case this allowance is 100% of £15000 + 3/20 X £7495 giving £16124.

So up to £16124 of your total withdrawals will be tax free.  But you have already withdrawn £2500 which would have been tax free at the time because of the 5% rule.  So the unused allowance is £16124-£2500=£13624.

So if you withdraw £20K now you may be charged tax on £20K-£13624=£6376


2) Calculate simple value of tax due

Withdrawals from investment bonds are charged to income tax but it is deemed that the bond has already paid basic rate tax.  So the amount of the withdrawal liable to tax is added to your other taxable income in the tax year and if the total is below the starting point for higher rate tax there is no further tax to be paid on the withdrawal.

So assume your taxable income from employment for the year was £40K.  Including that portion of the withdrawal liable to tax gives you £46376 which is below the start of higher rate tax.  Therefore you will not be taxed on your withdrawal.

However if your taxable income was £50K then your withdrawal would put you into the higher rate band and you would have to pay the higher rate component 20% tax on the excess or more if the withdrawal took you into the even higher bands.

Or you may not because of a further complication known as "top slicing" which can remove the liability to higher rate tax if the withdrawal takes you from basic rate into a higher rate band.  However I wont try to explain this unless you are in that situation.

Wow 😮 this is much more complicated than l thought!!

I had a look through my old statements and list the results below. Also l am a basic rate tax payer this year 23/24 my annual income will be approx £22k .

At some point before June 2008 (the earliest statement l could find) l had already made the £2500 withdrawal because it is mentioned on it. Below is the opening balance and payments added each year. 

O/Bal June 2008 £2592    Reg Payments £960   
"     "    "      2009 £3352    Reg Payments £960
                   2010 £4420    Reg Payments £1917 + Single payment £5500
                   2011 £12030  Reg Payments £ ******missing information
                   2012 £14421  Reg Payments £ 2004
                   2013 £17041  Reg Payments £2004
                   2014 £19918  Reg Payments £2004
                   2015 £23005  Reg Payments £2004
                   2016 £24594  Reg Payments £1002
                   2017 £26072

There has been no payments made into the account since Dec 2016. The total cash in value stands at £35,351.

Does this make the calculation easier? 

Linton

carboot_karaoke said:

Linton said:

There is no simple explanation of investment bond taxation!  

To illustrate the basic principles...

Assume this is a standard onshore investment bond, which it almost certainly is.
Assume you will be withdrawing £20K in the 2023/2024 tax year
Assume that £15000 was contributed in 1997 and £7495 in 2020.
Asdume you withdrew £2500 in 2010


1) Determine amount of withdrawal liable for tax:

There is a tax free allowance of 5% of the contribution per year.  So in the assumed case this allowance is 100% of £15000 + 3/20 X £7495 giving £16124.

So up to £16124 of your total withdrawals will be tax free.  But you have already withdrawn £2500 which would have been tax free at the time because of the 5% rule.  So the unused allowance is £16124-£2500=£13624.

So if you withdraw £20K now you may be charged tax on £20K-£13624=£6376


2) Calculate simple value of tax due

Withdrawals from investment bonds are charged to income tax but it is deemed that the bond has already paid basic rate tax.  So the amount of the withdrawal liable to tax is added to your other taxable income in the tax year and if the total is below the starting point for higher rate tax there is no further tax to be paid on the withdrawal.

So assume your taxable income from employment for the year was £40K.  Including that portion of the withdrawal liable to tax gives you £46376 which is below the start of higher rate tax.  Therefore you will not be taxed on your withdrawal.

However if your taxable income was £50K then your withdrawal would put you into the higher rate band and you would have to pay the higher rate component 20% tax on the excess or more if the withdrawal took you into the even higher bands.

Or you may not because of a further complication known as "top slicing" which can remove the liability to higher rate tax if the withdrawal takes you from basic rate into a higher rate band.  However I wont try to explain this unless you are in that situation.

Wow 😮 this is much more complicated than l thought!!

I had a look through my old statements and list the results below. Also l am a basic rate tax payer this year 23/24 my annual income will be approx £22k .

At some point before June 2008 (the earliest statement l could find) l had already made the £2500 withdrawal because it is mentioned on it. Below is the opening balance and payments added each year. 

O/Bal June 2008 £2592    Reg Payments £960   
"     "    "      2009 £3352    Reg Payments £960
                   2010 £4420    Reg Payments £1917 + Single payment £5500
                   2011 £12030  Reg Payments £ ******missing information
                   2012 £14421  Reg Payments £ 2004
                   2013 £17041  Reg Payments £2004
                   2014 £19918  Reg Payments £2004
                   2015 £23005  Reg Payments £2004
                   2016 £24594  Reg Payments £1002
                   2017 £26072

There has been no payments made into the account since Dec 2016. The total cash in value stands at £35,351.

Does this make the calculation easier? 

Even if you had not accrued any tax free allowance £22k income means that you can withdraw £50275-£22k= approx £28k from your investment bond without any tax charge. 

Whether you could withdraw the full £35351 is more complicated.  A worst case scenario would be if all your contributions had been made in 2017 giving you an unused tax allowance of (£22495 contribution -£2500 previously withdrawn) x 6/20 which is about £6k. Since £28k of the withdrawal is already covered one does not need to do the detailed maths to see that a full withdrawal should also be tax free.

lindabea

OP - Sorry to jump in on your thread, but I wonder if I can continue with this thread by asking Linton to address a very similar question for me.  

My partner also has one these investment bonds with the Pru which he is considering cashing in.  He started it in 2001 by making a one-off payment of £20000.  He never made any withdrawals since it's inception.  The current cashing in value is £53000.  His income for this year is likely to be £22500 made up as follows

State/Private pension   £18900
Savings int                    £1100
Dividend                        £2500 

We worked out that the gain of £33000 plus his income will push him into the higher rate of tax; so, we would have to use the top slicing relief.  However, this is becoming rather complicated to work out, but from what we learnt so far, we don't think that when applying TS relief, he will be liable for additional tax - but we're not sure. 

I'm not asking for an explanation of how TS is worked out as I know it's complicated to explain, but can i please ask you to let me know if he will be liable to additional tax with the figures I gave you above.         

Linton

lindabea said:

OP - Sorry to jump in on your thread, but I wonder if I can continue with this thread by asking Linton to address a very similar question for me.  

My partner also has one these investment bonds with the Pru which he is considering cashing in.  He started it in 2001 by making a one-off payment of £20000.  He never made any withdrawals since it's inception.  The current cashing in value is £53000.  His income for this year is likely to be £22500 made up as follows

State/Private pension   £18900
Savings int                    £1100
Dividend                        £2500 

We worked out that the gain of £33000 plus his income will push him into the higher rate of tax; so, we would have to use the top slicing relief.  However, this is becoming rather complicated to work out, but from what we learnt so far, we don't think that when applying TS relief, he will be liable for additional tax - but we're not sure. 

I'm not asking for an explanation of how TS is worked out as I know it's complicated to explain, but can i please ask you to let me know if he will be liable to additional tax with the figures I gave you above.         

With topslicing relief you divide the gain by the number of years to which it applies to give an average per year gain.  If as in this case the use of the average gain in the tax calculation would not put you into the 40% tax band then there will be no tax due.

Warning: my understanding is limited to simple cases and both examples in this thread are simple cases.  Investment bond taxation can get much more complicated!

lindabea

Thank you Linton for your reply. Much appreciated

Doctor_Who

I had to deal with investment bond taxation for my late Mother's estate. There were considerable gains since the bonds were bought in the 1980s, but over 30 years was available for top slicing. As Linton says, if the gain divided by number of years held, when added to your other income, doesn't push you into the higher tax band, no extra tax is due (20% tax is deemed to have been paid on the bond itself). One thing to be wary of though is that the total gain (no top slicing) is used to calculate the personal allowance. Since my Mother's gain was a solid 6 figures she lost all of her personal allowance.

carboot_karaoke

Linton said:

carboot_karaoke said:

Linton said:

There is no simple explanation of investment bond taxation!  

To illustrate the basic principles...

Assume this is a standard onshore investment bond, which it almost certainly is.
Assume you will be withdrawing £20K in the 2023/2024 tax year
Assume that £15000 was contributed in 1997 and £7495 in 2020.
Asdume you withdrew £2500 in 2010


1) Determine amount of withdrawal liable for tax:

There is a tax free allowance of 5% of the contribution per year.  So in the assumed case this allowance is 100% of £15000 + 3/20 X £7495 giving £16124.

So up to £16124 of your total withdrawals will be tax free.  But you have already withdrawn £2500 which would have been tax free at the time because of the 5% rule.  So the unused allowance is £16124-£2500=£13624.

So if you withdraw £20K now you may be charged tax on £20K-£13624=£6376


2) Calculate simple value of tax due

Withdrawals from investment bonds are charged to income tax but it is deemed that the bond has already paid basic rate tax.  So the amount of the withdrawal liable to tax is added to your other taxable income in the tax year and if the total is below the starting point for higher rate tax there is no further tax to be paid on the withdrawal.

So assume your taxable income from employment for the year was £40K.  Including that portion of the withdrawal liable to tax gives you £46376 which is below the start of higher rate tax.  Therefore you will not be taxed on your withdrawal.

However if your taxable income was £50K then your withdrawal would put you into the higher rate band and you would have to pay the higher rate component 20% tax on the excess or more if the withdrawal took you into the even higher bands.

Or you may not because of a further complication known as "top slicing" which can remove the liability to higher rate tax if the withdrawal takes you from basic rate into a higher rate band.  However I wont try to explain this unless you are in that situation.

Wow 😮 this is much more complicated than l thought!!

I had a look through my old statements and list the results below. Also l am a basic rate tax payer this year 23/24 my annual income will be approx £22k .

At some point before June 2008 (the earliest statement l could find) l had already made the £2500 withdrawal because it is mentioned on it. Below is the opening balance and payments added each year. 

O/Bal June 2008 £2592    Reg Payments £960   
"     "    "      2009 £3352    Reg Payments £960
                   2010 £4420    Reg Payments £1917 + Single payment £5500
                   2011 £12030  Reg Payments £ ******missing information
                   2012 £14421  Reg Payments £ 2004
                   2013 £17041  Reg Payments £2004
                   2014 £19918  Reg Payments £2004
                   2015 £23005  Reg Payments £2004
                   2016 £24594  Reg Payments £1002
                   2017 £26072

There has been no payments made into the account since Dec 2016. The total cash in value stands at £35,351.

Does this make the calculation easier? 

Even if you had not accrued any tax free allowance £22k income means that you can withdraw £50275-£22k= approx £28k from your investment bond without any tax charge. 

Whether you could withdraw the full £35351 is more complicated.  A worst case scenario would be if all your contributions had been made in 2017 giving you an unused tax allowance of (£22495 contribution -£2500 previously withdrawn) x 6/20 which is about £6k. Since £28k of the withdrawal is already covered one does not need to do the detailed maths to see that a full withdrawal should also be tax free.

Thank you this is massively helpful 😊

lindabea

Doctor_Who said:

I had to deal with investment bond taxation for my late Mother's estate. There were considerable gains since the bonds were bought in the 1980s, but over 30 years was available for top slicing. As Linton says, if the gain divided by number of years held, when added to your other income, doesn't push you into the higher tax band, no extra tax is due (20% tax is deemed to have been paid on the bond itself). One thing to be wary of though is that the total gain (no top slicing) is used to calculate the personal allowance. Since my Mother's gain was a solid 6 figures she lost all of her personal allowance.

Can you please explain what you mean by 'the total gain is used to calculate the personal allowance'.  Do you mean that the  personal allowance is deducted from the bond gain rather than allocating the PA against other income?  If that's the case, then all other income becomes taxable in the year the bond is cashed in ending up paying tax which you would not have otherwise paid.  .   

dunstonh

My partner also has one these investment bonds with the Pru which he is considering cashing in.  He started it in 2001 by making a one-off payment of £20000.  He never made any withdrawals since it's inception.  The current cashing in value is £53000.  His income for this year is likely to be £22500 made up as follows

Pru bonds from that era are usually very good.  Nice steady eddie on the returns and before they started charging people for the guarantees.  Plus, outside of any means tested benefits (i.e. you could have £1m in one of these and still get benefits)

Your partner should give careful consideration as to whether they should cash it in as you cannot get these anymore.

They can form the safer part or a wider portfolio if necessary.